Executive Compensation Consultants and CEO Pay

This Article surveys recent empirical studies on the relation between compensation consultants and CEO pay. The economic rationale for using executive compensation consultants is that they supply valuable data, information, and professional expertise to client firms. However, critics argue that the consultant’s independence might be compromised because of conflicts of interest arising from the cross selling of business services or because of the consultant’s desire to obtain repeat business. The emergent empirical evidence suggests that pay consultants are important in explaining executive compensation, although the findings are sometimes mixed and the precise effects of consultants on pay are yet to be fully understood.

In addition, this Article provides some new evidence on the correlation between CEO pay and consultants using U.S. and U.K. data. Adopting a slightly different approach to prior studies, I show that there is a positive cross-section correlation between executive pay and compensation consultants. Conditional on the estimation strategy, the existing evidence supports the hypothesis that CEOs of U.K. firms using consultants receive higher pay than those that do not use compensation consultants. There is less evidence that firms facing conflicts of interest, such as supplying other business services, are associated with higher levels of CEO pay. However, the findings may be sensitive to the type of estimation methods employed, and addressing this concern is a challenge for future research. I also find little support for the hypothesis that firms switch consultants as a mechanism of increasing CEO pay. Again, interpreting the data is fraught with difficulties because of selection effects and the possibility of reverse causation.

Finally, the recent Dodd-Frank Act significantly upgrades disclosure about executive compensation and compensation advisors. Future research on the efficacy of compensation consultants will undoubtedly take advantage of these new provisions. At present, it is difficult to unambiguously conclude that pay consultants simply promote executive interests at the expense of shareholders, or that pay outcomes and contracts are not optimal.

This entry was posted
on Wednesday, March 30, 2011 at 2:02 PM and is filed under Articles, Volume 64, Number 2, Volumes.
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